The Federal Deposit Insurance Corporation (FDIC) was
required by the Federal Deposit Insurance Reform Conforming Amendments Act of
2005 (FDIRCAA) to study the feasibility and consequences of privatizing deposit
insurance, establishing a voluntary deposit insurance system for deposits in
excess of the maximum amount of FDIC insurance, and increasing the limit on
deposit insurance coverage for municipalities and other units of general local
government. In February 2007, the FDIC sent its report to Congress. This
article summarizes the FDIC's findings on the first issue: privatizing deposit
insurance. Subsequent editions of the FDIC
Quarterly will report the FDIC findings on the other two issues.

Introduction

Since
its inception in 1933, the federal deposit insurance system has promoted financial
market stability, protecting the economy from the disruptive effects of bank
failures as well as protecting the deposits of small savers. Notwithstanding
the successes of the federal deposit insurance system, some have argued that a
private deposit insurance system would be an improvement. The FDIC explored privatization arguments in great depth in 1998
as part of Confidence for the Future: An FDIC Symposium. After almost ten years
and the enactment of the Federal Deposit Insurance Reform Act (FDIRA),
the FDIC has revisited the privatization debate. This article presents the
FDIC's most relevant findings.

The
article begins with a review of the general arguments in favor of
privatization. These generally are that privatization would diminish moral
hazard, reduce unwarranted government supervision and regulation of depository
institutions, and eliminate taxpayer responsibility for losses arising from
systemic failure. The article next reviews specific privatization proposals and
examines the validity of the assumptions underlying these proposals. The
article concludes with a discussion of other considerations important to the debate
about private versus public deposit insurance. These considerations include the
historical record of private deposit insurance systems, the sufficiency
of private capital to underwrite a private deposit insurance system, the cost
of deposit insurance in the absence of the federal guarantee, and other public policy concerns.

The
FDIC finds that the conclusions reached in 1998 continue to hold today––namely,
that privatization is not a remedy for problems arising from deposit insurance.

Arguments for Privatizing Deposit Insurance

Privatization
proponents generally maintain that the costs arising from a government–run
deposit insurance system are greater than the benefits, that the problems associated
with a government–run deposit insurance system are inherent and insurmountable,
and that the only solution to the problems is to privatize deposit insurance.
The various reasons given for this stance, as outlined in the next section, are
different but overlapping and generally involve concerns about moral hazard,
government supervision and regulation, and a perception that some institutions
are "too big to fail."

Concerns about Moral
Hazard. In the insurance context, the term "moral hazard" refers to the
tendency of insured parties to take on more risk than they would if they had not
been indemnified against losses. The argument is that deposit insurance
reassures depositors that their money is safe and removes the incentive for
depositors to critically evaluate the condition of their bank. With deposit
insurance, unsound banks typically have little difficulty obtaining funds, and
riskier banks can obtain funds at costs that are not commensurate with their
levels of risk. Unless deposit insurance is properly priced to reflect risk,
banks gain if they take on more risk because they need not pay creditors a fair
risk–adjusted return. A truly risk–based assessment discourages such risky
behavior.1
The moral hazard
problem is particularly acute for insured depository institutions that are at
or near insolvency but are allowed to operate freely because any losses are
passed on to the insurer, whereas profits accrue to the owners. Thus problem
institutions have an incentive to take excessive risks with insured deposits in
the hope of returning to profitability.

The Modern Deposit Insurance System

Although federal deposit insurance was implemented in
the United States in 1933, the modern federal deposit insurance system has been shaped by
legislative changes during the past two decades. In the 1980s, a crisis in the
savings and loan industry culminated in the insolvency of the Federal Savings
and Loan Insurance Corporation (FSLIC) and taxpayer funding of the FSLIC's
deposit insurance obligations. Almost concurrently, a similar crisis in the
banking sector–the worst since the 1930s–nearly exhausted the resources of the
FDIC's deposit insurance fund. Congress responded to the two crises by
reevaluating the federal deposit insurance system and enacted a series of
reforms. One was the Federal Deposit Insurance Corporation Improvement Act of
1991 (FDICIA). Many of FDICIA's provisions were designed to remedy the
weaknesses in the deposit insurance system that the recent crises had brought
to light. Specifically, FDICIA–

Required the banking industry to recapitalize the deposit
insurance funds, reducing the likelihood the public would have to fund deposit
insurance obligations in the future.

Permitted the FDIC to borrow up to $30 billion from the
Treasury so that funds would be available to close and resolve insolvent
institutions quickly.

Mandated that the FDIC use the least costly solution to
resolve bank failures. An exception may be made in the case of systemic risk,
which requires a recommendation by at least two–thirds of the FDIC Board of
Directors and the Board of Governors of the Federal Reserve, and an emergency
determination by the Secretary of the Treasury in consultation with the
President.

Recently,
Congress again addressed deposit insurance, enacting the Federal Deposit
Insurance Reform Act of 2005 (FDIRA), which built on the reforms instituted
under FDICIA. FDIRA–

Merged the Bank Insurance Fund (BIF) and the Savings
Association Insurance Fund (SAIF) into a single Deposit Insurance Fund (DIF).

Allowed the FDIC to manage the level of the DIF within a
certain range.

Allowed the FDIC to charge risk–based premiums regardless of
the level of the reserve ratio.

Authorized a one–time credit toward future assessments for
institutions that replenished the insurance funds in the early 1990s and
provided for dividends when the reserve ratio reaches certain thresholds.

Authorized future increases in insurance coverage levels to
adjust for inflation and immediately increased the insurance coverage limit of
retirement accounts to $250,000.

Concerns about Government
Supervision and Regulation. A major concern of some privatization
proponents is the degree of government oversight they consider to be a
by–product of government–sponsored deposit insurance. They argue that
government–sponsored deposit insurance is responsible for intrusive
regulations, product restrictions, and social obligations that are placed on
insured banks and thrifts. They contend that without government–sponsored
insurance there would be no need to subject banks to intense safety–and–soundness
regulation and to limit the products they might offer or their business
affiliations.2
They claim that the regulations made necessary by deposit insurance not only
limit choices and opportunities, they also hinder rapid response to changes in
the business environment and are expensive. Inasmuch as costly regulations are
imposed on only one segment of the financial industry (depository
institutions), insured depository institutions are less competitive than
financial providers that are not so encumbered. As described in the next
section, many proponents of privatization therefore seek to decouple deposit
insurance from the "full faith and credit" of the U.S. government, or otherwise
reduce a perceived taxpayer risk, to remove the justification for federal
supervision and regulation of the banking industry.3

Concerns about "Too–Big–to–Fail"
(TBTF). Privatization proponents are especially critical of the
systemic–risk exception provided in the Federal Deposit Insurance Corporation
Insurance Corporation Improvement Act (FDICIA) because they argue that it has
the potential to shift the costs for megabank failures to the taxpayer.4
They argue that when Congress provided a statutory exception from the
least–cost resolution in the case of systemic risk, it acknowledged that
certain depository institutions were too big to fail. Thus, because of size or
perceived importance to the financial system, large institutions' uninsured
depositors and unsecured creditors are treated differently from those of smaller
institutions. As long
as the full–faith–and–credit backing of the U.S. Treasury supports deposit
insurance, they allege that taxpayers inevitably will be responsible for any
losses resulting from large bank failures.

Consistent
with concerns about moral hazard, proponents of privatization generally favor
market–oriented alternatives to federal deposit insurance. One proposal would
replace publicly provided deposit insurance with a system of cross–guarantees
under which small groups of banks would form syndicates with joint and several
liability for the deposits of banks that contracted with them.5
Another proposal would convert the FDIC into a privately owned and operated
insurance company, reducing the current system's reliance on regulation and
guidance.6 A
third proposal would transfer ownership and management of the FDIC to the banks
and would set an explicit limit on the use of deposit insurance in order to
encourage market discipline.7 A
fourth would retain the FDIC as a public entity but would reduce its powers.8

A common theme among these proposals is a rollback of bank
supervision and regulation. Most seek to reduce the regulatory and supervisory powers of bank
regulatory agencies to allow banks to become competitive, full–service
providers of financial products and services. One proposal would exempt
banks from federal safety–and–soundness regulations and reporting requirements,
replacing them with private restrictions by member banks.9
This proposal would also abolish the FDIC and the regulatory and supervisory
functions of the Federal Reserve Board (FRB), the Office of the Comptroller of
the Currency (OCC), and the Office of Thrift Supervision (OTS). Another
proposal would recognize well–capitalized, well–managed institutions with less
extensive regulation, expanded product opportunities, and lower regulatory
"taxes."10

Many proposals are particularly concerned with the issue of
TBTF. Most proposals would provide deposit insurance coverage for small
deposits only. All seek to protect the taxpayer from responsibility for a
systemic collapse by preventing the insurer from funding a systemic–risk
exception. Most proposals would eliminate the full–faith–and–credit backing of the
insurer as well as the insurer's line of credit with the Treasury. However, one
proposal sees the need for a bank–funded backup fund to explicitly protect
insured deposits against a systemwide collapse.11

Evaluation of Privatization Claims

Can Privatization Alleviate the Moral Hazard
Problem?

Proponents
of privatization generally assume that the moral hazard fostered by deposit
insurance can be eliminated through privatization. In fact, the problem of
moral hazard is inherent in insurance itself, regardless of management or
ownership. The private provision of deposit insurance does not by itself
alleviate the moral hazard problem.

Although
moral hazard was clearly problematic in the savings and loan crisis, subsequent
improvements in federal banking regulation and supervision have given the FDIC
better tools to control moral hazard. The moral hazard problem created by
deposit insurance has been mitigated by capital standards, examinations,
safety–and–soundness regulations, enforcement actions, and timely bank closure
policies. In particular, Prompt Corrective Action (PCA), introduced under
FDICIA, has been effective in preventing banks with low capital levels from
taking on excessive risk in an effort to return to profitability while the FDIC
bears the risk. A properly constructed risk–based premium assessment system can
also address moral hazard, and the FDIRA has enhanced the FDIC's ability to
manage the insurance fund and set premiums according to the riskiness of the
insured entity.

Would Privatization Release the Banking Industry from Unnecessary Regulatory
Constraints?

A
privately funded and administered system of deposit insurance would not free
the banking industry from all regulation and constraints. Many nations have
privately administered deposit insurance systems and all still impose systems
for bank supervision and regulation. Bank supervision predates the federal
deposit insurance system. Many bank regulations do not flow from the FDIC as
deposit insurer but instead are imposed by the chartering and supervisory
authorities, including not only the FDIC, but the OCC, the OTS, the FRB, and
state banking authorities. Much of the regulatory burden on insured
institutions flows from statutes and regulations unrelated to deposit
insurance. For instance, one month
after the events of September 11, 2001, the USA PATRIOT Act was passed. The USA
PATRIOT Act amended the Bank Secrecy Act, with which banks must comply. Several
provisions and implementing rules were added to bankers' compliance
obligations. Reporting requirements under such laws are unrelated to deposit
insurance coverage and are unlikely to be eliminated if deposit insurance is
privatized.

Public
policymakers are unlikely to abandon concern for prudent banking practices if
deposit insurance reverts to the private sector. In 1998, then U.S. Representative
James Leach expressed this idea clearly when he noted, "Because a sound economy
requires a safe and sound banking system, public liabilities exist even if
public funds are not placed in jeopardy by statute."12
Even without federal deposit insurance, policymakers would remain concerned
about implicit public guarantees. These concerns likely would be manifest in government
regulation designed to promote the efficient operation of the financial system and
ensure the protection of taxpayers and individual savers.

It
is more likely that, in addition to continued
public regulation, a privately owned and profit–seeking deposit insurer would
demand oversight. At a minimum, any prudently operated for–profit deposit
insurer would probably require adherence to best practices and
would insist on access to management and site visits to monitor the condition
and riskiness of the institution it insured. It is unlikely that the private
insurer would rely on market–generated information alone. Virtually all insurance policies––health, life, and
liability––contain restrictions and limitations on coverage as well as
conditions on approval in order to control risk.

For instance, American Share Insurance
Company, a private primary and excess deposit insurer to credit unions,
requires monthly financial reports from its members, examines them regularly,
and supervises them closely. A review of the history of state–sponsored deposit
insurance plans also reveals that the more successful private insurers were
extremely vigilant in regulating and supervising member banks. In the pre–Civil
War Indiana plan, regarded by some as the best
of the nonfederal deposit insurance plans, insured banks were branches of the
State Bank of Indiana.
Bank examinations were semiannual, and the directors of the State Bank had
powers that exceeded those granted to bank regulators today. The State Bank of Indiana also had the
authority to dictate whether banks in the state expanded or contracted the availability
of credit, and on occasion it exercised this authority. In contrast (as
described below), weak supervision of member banks was considered a major
factor in the collapse of the Ohio, Maryland, and Rhode Island private deposit
insurance plans in 1985 and 1991. It is unclear, therefore, how the change from
a public to a private deposit insurance system would affect the regulatory
constraints under which the banking industry operates.

Would Privatization Protect the Taxpayer from Responsibility for Losses
from a Systemic Failure?

Several of the privatization proposals call for eliminating the government's ability to exercise a systemic risk exception
to the least–cost resolution requirement in FDICIA. They maintain that when
Congress provided a statutory exception from this requirement in the case of
systemic risk, it acknowledged that certain depository institutions were too big
to fail. They believe that uninsured depositors and creditors of large
institutions may be treated differently than those of smaller institutions.13

Economic Policy
Issue. The possibility of a systemic risk
determination––which allows government intervention to prevent broader problems––is
not simply a deposit insurance issue, but rather an economic issue that is best
evaluated within the context of a wider public policy debate. Eliminating
the possibility of a systemic risk exception would require a government
commitment to allow banks––and in the broader context, other very large and
important businesses––to fail even when their failure would jeopardize the
stability of the U.S.
financial system. If the failure of a private firm were to threaten the
stability of the U.S.
economy––whether that firm were a bank, a financial services company, or a nonfinancial
business––it is unrealistic to assume that the government would not intervene
in the national interest. History is replete with examples of such
intervention.

In
the United States, the federal government has provided financial assistance to
avoid large corporate bankruptcies (for example, Chrysler and Lockheed), assisted the banking and
financial sectors when they were threatened by the less–developed–country debt
crisis in the 1980s, and provided financial aid to the Mexican
government––an important trading partner––during that country's financial crisis
in 1995.

More recently, ten days after the terrorist attacks of
September 11, 2001, Congress passed a $15 billion package of direct cash
infusion and loan guarantees to aid the domestic airline industry.
Subsequently, when affordable commercial terrorism insurance became
unavailable, Congress passed temporary legislation that established a federal
government backstop for 90 percent of insured losses resulting from certain
terrorist acts up to an annual $100 billion industry–aggregate limit.14
(In December 2005 this legislation was modified to reduce the government's
potential liability.)

Foreign governments have also intervened when their financial
systems are in distress. In the early 1990s, Norway
and Sweden
stepped in when their banking systems came under severe stress. Japan has launched
several expensive bailouts of its banks in the recent past, and the so–called
"East Asian Tiger" countries (South Korea, Thailand, Indonesia, and others),
responding to the global currency crisis in the late 1990s, undertook massive
interventions to strengthen their financial sectors. In fact, the vast majority
of industrialized nations in modern history have intervened to save their
largest banks as a means of protecting their financial systems.15

Reduced Potential for a Systemic Situation. Reforms enacted in 1991
as part of FDICIA make a potential bank failure substantially less likely to
pose a systemic risk. Certain provisions in FDICIA were designed specifically
to reduce systemic risk. They include PCA (with the establishment of capital
requirements), limits on interbank credit exposures, final net settlement
authority, and reinforcement of netting provisions for interbank payments.
Additionally, authority provided by FDIRA has enabled the FDIC to make the
premium structure more risk–focused and discourages moral hazard. Finally, the
use of certain failed–bank resolution techniques, including the use of bridge
banks and advance dividend payments to uninsured claimants, has mitigated some
of the adverse consequences associated with bank failures. Overall, these
powers and policies make it less likely that bank regulators and policymakers will
need to invoke a systemic risk determination under FDICIA.

Greater Difficulty Making a Systemic Risk
Determination. FDICIA also requires that
in order to make a systemic
risk determination and waive the least–cost requirement for resolving insolvent
institutions, the Secretary of the Treasury, in consultation with the President,
must determine that there would be "serious adverse effects on economic
conditions or financial stability." Such a decision can be reached only after
favorable written recommendations from both the FDIC Board of Directors and the
Board of Governors of the Federal Reserve System, with at least two–thirds of
the members of each board voting in favor of the recommendation. FDICIA further
requires that the Government Accountability Office review any determination
under this extraordinary exception.16 These
requirements ensure that a systemic risk determination can be made only after
serious discussions at the highest levels of government.

Funding the Costs of a Systemic Risk Determination. FDICIA also affords
taxpayers an additional layer of protection in the event of a systemic risk
determination. The law requires that banks pay a special assessment to the FDIC
to recoup the amount by which the resolution cost exceeds what it would have
been under the least–cost resolution requirement.17

Systemic Risk and Too Big to Fail Are Not Synonymous. Finally, it is important
to emphasize that the systemic risk exception does not protect large banks from
failing: large banks can still fail, with stockholders, uninsured depositors,
and creditors incurring losses. FDICIA permits the FDIC to waive the least–cost
resolution requirement only where there is systemic risk, which might result in
more protection for uninsured depositors and unsecured creditors than under a
nonsystemic bank failure. However, as mentioned above, FDICIA provisions make
this scenario less likely.

Other Considerations: History,
Availability, Cost, and Public Policy

Other
considerations raise questions about the advisability of replacing
public deposit insurance with a private system. One such consideration is the
fate of past private deposit insurance systems in the United States.18
Another is the ability of private capital to underwrite a private deposit
insurance system. Cost in the absence of the federal guarantee and the public
policy perspective on deposit insurance also are important considerations.

History and Lessons of Private
Deposit Insurance in the United
States

The state of New York implemented the
first deposit insurance plan in the United States in 1829, and between
then and the Civil War, five other states created programs. In all these
programs, the emphasis was on protecting holders of banknotes rather than
depositors. Three of the insurance plans failed, and the other three vanished
soon after the establishment of the National Banking System. After the panic of
1907, eight mostly midwestern states created mutual deposit insurance systems.
All these plans failed by 1931. After the 1930s, at least 30 additional
nonfederal insurance plans were established to protect the deposits of all
depository institutions––banks, thrifts, industrial banks and industrial loan
companies, and credit unions. Most of these plans failed or ceased operation
during the thrift crisis of the 1980s. Others were phased out when their
sponsoring states decided, after witnessing the problems elsewhere, to require
federal deposit insurance for all state institutions. Today, no private
provider of primary deposit insurance to banks and savings associations remains.
(American Share Insurance Company continues to provide primary and excess
deposit insurance to credit unions.)

With a couple of exceptions, these private deposit insurance plans
were sponsored by state governments, though the states did not back the plans
financially. Almost all the plans were mutual insurance funds, though three of
the early plans were based on a system of mutual guarantees in which banks
guaranteed one another's banknotes. One completely privately held company began
insuring credit union deposits in 1962, and several private companies provided
reinsurance for deposits until they left the business in the mid–1980s.

Historically, private insurance plans have had to contend with two
serious issues: concentration of risk and lack of liquidity in the midst of a
crisis. Nearly all private insurance plans collapsed because of the failure of
one or more large insured institutions. In many of these cases, insured
depositors either were not protected (or were protected only with substantial
assistance from state taxpayers) or received access to their funds only after a
prolonged delay.

One study of the
commonalities of failed private deposit insurance systems in the United States
found that these systems typically shared five characteristics: (1) free exit
from the system; (2) concentration risk (the failure of large institutions often
brought down the entire system); (3) fraudulent acts by regulators, banks, and
politicians; (4) limited regulatory powers; and (5) inaction on the part of
insurers and state regulators.19

Many of the failed systems actually had relatively high reserve
ratios when their crises occurred. However, they were unable to handle the
failure of a very large member of their system. The system could not ensure
immediate access to depositor funds (i.e., the system was not able to fulfill
the liquidity function of an insurer), and this lack of liquidity eroded public
confidence, which in turn led to runs on other member banks, overwhelming the
entire system. Typically, deposits were frozen, and state governments had to
step into the breach. Lacking funds to cover the insured deposits immediately,
the states generally repaid them over a period of time, sometimes years.

In the more recent failures of private insurance systems (Ohio
and Maryland in 1985, Rhode Island in 1991), many insured depositors had to
wait months––and in the case of Maryland,
years––to receive the full return of their principal.20
Ohio was forced to commit $151 million of
nontax revenues to support a bond issue to fund depositor claims; most Ohio depositors received
full availability of their funds within six months. Maryland committed state–sponsored bond
revenues sufficient to satisfy insured depositor claims over a five–year period. Some depositors did
not receive their funds in full until 1989, four years after failure. Rhode Island requested
and received a federal loan guarantee
of the state bonds it issued to satisfy insured depositor claims. In the end, Rhode Island covered the
losses on its own, and depositors eventually received their funds in full,
although many had to wait at least a year after the failure of the state
deposit insurance fund.

As the history of private deposit insurance systems suggests,
private insurers have been unsuccessful in fulfilling allthree of the responsibilities traditionally assumed by federal
deposit insurance.21
A private, industry–funded deposit insurer not only needs enough resources to
protect small depositors but also must be capable of providing stability to the
entire banking system, especially in times of great financial and economic
turmoil. Insufficient public confidence in the deposit insurance guarantee could
render the system unable to prevent or stem banking panics.

There
are legitimate questions as to whether any private deposit insurance system could
attain or maintain the necessary level of confidence in the deposit guarantee
to prevent market instability during times of financial or economic turmoil. As
history has shown, the insurance system must have not only the resources to
handle isolated failures but the ability to handle catastrophes. Bank failures
often come in waves––with one failure building on, and leading to, another. During
a crisis, a private insurance fund typically must acquire financing from the
banking industry through its line of credit––or from other private sources––at a
time when the entire industry and perhaps the economy is in financial trouble.
This is expensive in the short run, and related interest costs can hamper
attempts to recapitalize the insurance fund for many years after the crisis has
passed.

It is
doubtful that depositors would continue to have confidence in a depleted or
weakened insurance fund unless the U.S. Treasury stood behind the deposit
guarantee. As Milton Friedman notes in his 1963 monetary history of the United States,
federal deposit insurance––

has succeeded in achieving
what had been a major objective of banking reform for at least a century,
namely, the prevention of banking panics. . . . [B]anking panics have occurred
only during severe contractions and have greatly intensified such contractions,
if indeed they have not been the primary factor converting what would otherwise
have been mild contractions into severe ones. That is why we regard federal
deposit insurance as so important a change in our banking structure and as
contributing so greatly to monetary stability––in practice far more than the
establishment of the Federal Reserve System.22

Availability of Private Capital

Another consideration is whether
enough capital is available to underwrite private deposit systems. In the
1990s, in keeping with a provision of FDICIA, the FDIC explored the feasibility
of establishing a private reinsurance system for deposit insurance.23
The resulting Marsh & McLennan study (2001) found that reinsurers had only
limited interest in engaging in reinsurance agreements with the FDIC on terms
acceptable to the FDIC. Doubts about the availability of sufficient private
capital to fund a private deposit insurance system were reinforced by events
following the terrorist attacks of September 11, 2001. As mentioned, subsequent
to September 11, the private insurance/reinsurance industry required a
government risk–sharing arrangement to continue providing commercial terrorism
insurance. The small number of private insurance firms currently providing
excess deposit insurance in the United
States (as will be described in a
forthcoming FDIC Quarterly article) also
heightens concern about the sufficiency of private capital to support a private
deposit insurance system.

Cost in the Absence of the Federal Guarantee

There is also the issue of cost. The
Marsh & McLennan study found that a reinsurance company's price for excess
deposit insurance coverage could be expected to be higher than if the FDIC were
providing the coverage, because reinsurers' pricing would represent a
free–market charge without government support.

Federal Reserve Chairman Alan Greenspan testified in 2002 about
the likely cost of deposit insurance in the absence of the federal guarantee.24
He stated that realistically, the government subsidy could not be eliminated
because, without it, the average premium would need to increase to such a high level
to insure against the improbable case of very large losses that most depository
institutions would be discouraged from offering broad insurance coverage. He
made the case that in deposit insurance, unlike life or casualty insurance,
each insured loss is not independent of others. Deposit–run contagion produces
a far larger extreme–loss tail on the probability distribution and therefore
requires substantially higher premiums to offset this risk. No private deposit
insurer would ever be able to match the FDIC premium and cover its risks.

Public Policy Perspective

An issue that has been
infrequently addressed in this debate is the difference between the goals of a
public deposit insurance system and the goals of a privately run system.25
These differences are considerable. To maintain economic stability, public
regulators historically have promoted the entry of newly chartered institutions
into banking markets and have encouraged vigorous competition among banking
organizations. Federal deposit insurance is available to all qualifying banks,
and it is not easily terminated. In contrast, the major objective of a private
system would be to maximize the profit of its deposit insurance business, not to
achieve any public policy goal. Under a mutual guaranty system, one might
expect members to be interested in minimizing cost, risk, and competition. To accomplish
this, it would not be surprising if a mutual insurance system denied coverage to
newly chartered or otherwise risky banks, or agreed to insure them only at very
high rates or for very short–term contracts.26

Summary

Privatization may not eliminate moral hazard, as moral
hazard is an effect of all types of insurance. Recent regulatory and statutory
improvements in federal banking law have given the FDIC better tools to control
moral hazard. Significant regulatory burden on banks is unrelated to deposit
insurance, and this burden will not necessarily end with privatization. It is
unclear how privatization would shield the taxpayer from responsibility for
losses arising from a systemic crisis more completely than does current law.
Government intervention in a systemic failure––to prevent broader problems––is a
macroeconomic policy issue, not a deposit insurance issue. The powers and
policies enacted in FDICIA and FDIRA have reduced the risk of a systemic
failure as well as made it considerably more difficult to make a systemic risk
determination and pass the associated costs to taxpayers. In fact, if
privatization eliminates the special assessment provisions that allow the FDIC
to recoup losses for a systemic risk determination from the banking industry,
privatization could actually increase taxpayer exposure in a systemic crisis.

The failure of earlier private insurance systems, the
availability of private capital to replace the federal guarantee, the cost of
deposit insurance in the absence of the federal guarantee, as well as the
public policy considerations, are other important factors in the privatization
debate. A review of the record of private deposit insurance systems in the United States
reveals that insufficient confidence in the private deposit insurance guarantee
increased the fragility of these systems and rendered them unable to prevent
panics. It is questionable whether a private insurer could enjoy a high degree
of public confidence unless the government stood behind the guarantee.
Additionally, the availability of private capital to underwrite a private
deposit insurance system is limited––a finding reinforced by insurers'
unwillingness, subsequent to September 2001, to provide terrorism insurance
absent a government loss–sharing agreement. Overall, the evidence suggests that
the costs of private deposit insurance would likely be prohibitively high, and
it is questionable whether the goals of a private system would coincide with
public policy goals.

1
As discussed below, historically the moral hazard problem created by deposit
insurance has also been mitigated by banking regulation and the supervision of
depository institutions. Among the regulatory actions that have been used to
reduce the risks associated with moral hazard are capital standards,
examinations, safety–and–soundness regulations, and enforcement actions.

2
See Bank Administration Institute and McKinsey & Co. (1996) and Kovacevich
(1996) for their arguments on deposit insurance and bank regulation.

17 12 U.S.C. § 1823(d)(4)(G)(ii) (2001). The assessment is proportional
to each bank's total assets less the sum of tangible equity and subordinated
debt. Larger banks rely more than smaller institutions on nondeposit
liabilities for funding. Therefore, the assessment would fall more heavily on
large institutions (the likely source of systemic problems) than if the assessment
were charged only on domestic deposits.

18
Historically, private deposit insurance systems have acted as primary insurers
(playing the FDIC's current role as insurer) or as excess deposit insurers
(providing insurance in addition to the FDIC insurance limit). As discussed
below, there are no longer any private primary insurers for banks and savings
associations in the United
States.

21
The responsibilities are to promote financial market stability by maintaining
depositor confidence in the banking system, to protect the economy from the
disruptive effects of bank failures, and to protect the deposits of small
savers.